Wednesday, December 30, 2015

The Case for Caution

by Osman Parvez
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With Google’s new building well underway, there has been considerable buzz in the real estate community about the potential impact. As everyone knows, home prices have risen dramatically during the past several years, not just because of Google, but due to a large influx of people moving to the Front Range and a shortage of available homes. Sounds like a recipe for continued strong appreciation. Is there a reason for caution? You bet. 

In the Bay Area, venture capital fuels startups to compete for and compensate early stage employees who in turn, hand over a significant chunk of their salaries to pay for housing. Buyer and renter competition for housing has has led to massive gains in the real estate sector for investors (and sadly, astronomic living costs). Many expect that sort of thing to occur here in Boulder, which has been fueling a recent frenzy for real estate assets. 

There’s a catch: We’re not Silicon Valley. Not even close. 

VC’s invested nearly $23BN in Silicon Valley startups during the first three quarters of 2015, according to PricewaterhouseCoopers and the National Venture Capital Association, based upon data from Thomson Reuters. How much did VC’s invest in Colorado? Only $513MM, or 2.3% of what was invested in Silicon Valley. 

The Light Is Flashing Yellow My advice to home buyers and real estate investors: Be cautious. 

Certain locations including northeast Longmont, parts of Erie, and Lafayette seem like attractive investments. Prices remain relatively low compared to Boulder and selection in some cases is far better. Developers are forging ahead in these areas and higher quality retail is following suit. Because commutes are generally 30 minutes or less, many investors expect an influx of worker bees to drive prices upward at an attractive rate of appreciation.  

Here’s the problem. Primary home values are closely tied with income and income growth has been slow for decades. Google and other high paying employers are not only concentrated in risky industry sectors prone to steep cycles, they also employ a small percentage of workers. When the contraction comes - and it will - marginal locations will likely correct faster and steeper. In short, the foundation for strong and sustainable appreciation is shaky.

What Can You Do?
One of the first items I ask my clients about is their investment objectives.  For sellers, it’s usually pretty simple. They want to sell their home quickly, for the least amount of hassle, and for the highest price possible. The smart ones also want indemnity against future liability. 

For home buyers and investors, the answer is more complicated. Expected holding period is often the driving factor. For flippers, the holding period is measured in months. For cash flow investors and most primary home buyers, holding period is measured in years and the ease with which they’ll be able to attract high quality tenants. 

If you’re forced to sell during a downturn and you’ve chosen a marginal location, there’s a very real chance of a loss of capital. That’s less likely for flippers who expect to be in and out of the asset well before a correction takes hold. In the past, real estate cycles have also been slower to correct than markets with better information flows. 

In other words, marginal locations pose acceptable risk for short term holds or flexible long term holds. If you’re moving your family into the home or you expect to hold the investment for the long term, flexibility for when you exit is extremely valuable. If you don’t have that flexibility and you care about capital preservation, it’s smarter to stick with locations that have less down-turn risk, namely Boulder. 

Always Exercise Due Diligence
There is no such thing as a risk-free real estate investment.  That's why it's important to (a) understand your own tolerance for risk and (b) thoroughly evaluate the risk of potential investments. When we represent home buyers, we advise our clients to consider 20 different categories of due diligence. And that's just the starting point.

If you want to make a smarter real estate decision, caution and due diligence are equally important when choosing your real estate adviser. Choose carefully.


Additional Reading 
House Einstein:  Google's New Campus and More
Denver Post:  Google breaks ground on new four-acre Boulder campus
PWC: The MoneyTree Report
BizWest: Boulder’s economic vitality weathers the storms
Westword:  Colorado Adds 100,986 People, Making It the Second Fastest-Growing State


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The ideas and strategies described in this blog are the opinion of the writer and subject to business, economic, and competitive uncertainties.   We strongly recommend conducting rigorous due diligence and obtaining professional advice before buying or selling real estate.   Image Credit:  Jiahui Huang via CC 2.0

1 comment:

  1. I've been reading this blog for a while. It's an interesting and informative set of information about my (now) local real estate market. Having lived through the Google invasion of Seattle, I can tell you that you are likely partially correct. The anecdotal evidence for home prices in the Kirkland, WA area was that they went up very quickly. I wish I had MLS access for King County to verify. That said, the 2008 financial crisis hit the Pac NW pretty hard, and home values didn't start to recover until late 2011. Inventory was (and continues to be) exceedingly tight in the Seattle market, especially for some of the more desirable neighborhoods.

    You are correct that this area is not Silicon Valley. We lack tech companies with escape velocity (rapid financial value growth), the population is quite a bit lower, and the tech ecosystem lacks volume of companies, which draws in the hordes of tech workers, which then drives up the market heat. There was some of this in Seattle, with the addition of Facebook, Google and other companies to the local infrastructure in the mid-2000s. Add to that the growth of Amazon in the South Lake Union district, Tableau as a local company that went big, and of course Expedia and Microsoft, and the recipe was there for rapid appreciation of home values due to lack of inventory, and high density of high wage earners.

    As a percent of overall population, I would wager the net inflow of Google employees relative to the total metro Boulder (note: not Denver) is greater than the ratio of Google/Facebook additions to metro Seattle. It will be interesting to see what happens. One thing I don't miss from Seattle is traffic.

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